Law professor in Wall Street Journal

In the spring of last year, two investment arms of J.P. Morgan Chase and Co. began accumulating shares in Rural Cellular Corp., a small Minnesota provider of mobile-phone service. The bank units, which hadn't previously owned any shares, reported a combined 2.4 percent stake at the end of June. The timing turned out to be fortunate for J.P. Morgan. On July 30, Rural Cellular's stock jumped 34 percent after the company announced it was being acquired by Verizon Wireless. The two sides had been negotiating since at least early May. The investment bank that advised Verizon Wireless in the deal: J.P. Morgan. Investment banks aren't allowed to trade on their inside information about potential mergers. But sometimes by chance, one arm of a bank will buy a stock without knowing that another arm is advising on a deal. That's what J.P. Morgan says happened with Rural Cellular. Regulators are now conducting a broad review of pre-deal trades by investment banks to determine if they were coincidences, or something else. It isn't clear what deals they're looking at. Their interest was sparked by a new academic study that finds such trading happens much more often than would be expected by chance. The study, which examines statistical patterns, concludes that some banks likely are trading on their inside information about deals. The Wall Street Journal, by reviewing stock-ownership and deal records, identified dozens of instances in which investment banks appeared to be buying shares in target companies around the same time their bankers were advising the acquirers. The transactions involved most of the major investment banks, including Citigroup Inc., Credit Suisse Group, Goldman Sachs Group Inc., Merrill Lynch and Co. and Morgan Stanley. The firms either declined to comment or said they found no problems with the trading. Andrei Simonov, one of the co-authors, says that the data don't prove wrongdoing. Nevertheless, he says, the pattern is so strong that "the most probable explanation is that banks are trading on inside information." Critics say the research is flawed. One issue is that quarterly filings provide an incomplete and sometimes outdated picture of a bank's true holdings. Not included, for example, are certain types of options. Behind the scenes, an investment bank holding stock simultaneously could be using options to hedge its position or to bet that the stock will decline. Henry Hu, a corporate and securities-law professor at the University of Texas at Austin, says the study's data "do not necessarily prove anything sinister is going on." The researchers acknowledge the limitations of the data. But they say it isn't likely that including the nonreported holdings would erase the statistical disparity between banks that served as advisers and banks that didn't.